At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." While the pinstripe-and-wingtip crowd is entitled to its opinions, we've got some pretty sharp stock pickers down here on Main Street, too. (And we're not always impressed with how Wall Street does its job.
Given this, perhaps we shouldn't be giving virtual ink to "news" of analyst upgrades and downgrades. And we wouldn't -- if that were all we were doing. Fortunately, in "This Just In," we don't simply tell you what the analysts said. We also show you whether they know what they're talking about.
Barclays backs Big Oil
Big Brit banker Barclays Capital gave Patterson-UTI Energy (Nasdaq: PTEN ) shareholders something to cheer about yesterday -- not that it helped them much. Upgrading the shares to "overweight," Barclays argued Patterson has "been unfairly punished over the last several months due to the company's exposure to [North America] and pressure pumping in particular." But sadly for shareholders, there was more punishment in store.
Despite Barclays' advice to buy, investors sold off Patterson instead -- down 2.2% yesterday, or nearly three times as bad as the drop on the Dow. Why?
After all, while it's true that Patterson's rig count has dropped, this is only what you'd expect given the prevailing "sub-$4 natural gas prices." More importantly, Barclays believes the poor environment for gas drilling "is well discounted in the shares" already. According to the analyst, this leaves Patterson shares selling for "a higher discount versus peers on an EV/EBITDA basis."
Indeed, the shares today trade for an enterprise value just 3.7 times the company's earnings before interest, taxes, depreciation, and amortization (EBITDA) for the past 12 months. That's as compared to the 5.0-times ratio at Nabors (NYSE: NBR ) , 5.7 ratio at Baker Hughes (NYSE: BHI ) , and 5.8 ratio at Helmerich & Payne (NYSE: HP ) . (Other drillers cost even more, with giant Transocean (NYSE: RIG ) costing 7 times EV/EBITDA, and Noble Corp. sporting a monster 11.7-times valuation.)
Let's go to the tape
But are even these numbers reason enough to think Patterson is undervalued? After all, it's not as if Barclays hasn't made mistakes in the past. In fact, historically, about 52% of this analyst's picks in the energy equipment and services industry have gone awry...
|
Company
|
Barclays Rating
|
CAPS Rating
(out of 5)
|
Barclays' Picks Lagging S&P by
|
| Transocean |
Outperform |
***** |
39 points |
| Noble |
Outperform |
***** |
27 points |
| Halliburton (NYSE: HAL ) * |
Outperform |
**** |
16 points |
*Halliburton, for the record, sells for a 5.8 EV/EBITDA -- right in line with H&P and B-H.
Profit from Patterson?
Of course, just because Barclays has been (very) wrong about companies in the same industry as Patterson in the past, doesn't mean it's wrong about Patterson today, right? After all, it only takes a quick glance at the stock to see what attracts Barclays to it. At 10 times earnings, but with growth projections hovering around 25% per year for the next five years, Patterson is a stock almost guaranteed to attract the attention of investors.
Problem is, I'm afraid investors focusing on the company's attractive PEG ratio (or even the EV/EBITDA ratio that so enthralls Barclays) are missing the point: Whatever kind of "earnings" the company seems to be producing, it's notably weak in producing something even more important: cash.
Show me the money!
Lots of investors focus on earnings -- also known as accounting profits -- when choosing companies to invest in. I get that, and it's not surprising, seeing as these are the numbers that the mainstream press most actively report. But personally, I've always been more interested in whether a company can generate real cash profits, put 'em in the bank, and show 'em to us, than simply gin up some good-looking accounting numbers. This, I think, is where the bull thesis on Patterson breaks down.
Over the past 12 months, a period in which Patterson claimed nearly $290 million in GAAP profits earned, the company actually burned through $157 million in negative free cash flow. Nor was 2011 exceptional in this regard. Patterson was similarly cash unprofitable in 2010, only barely in the black in 2009, and generated significantly less free cash than it reported as GAAP profits in each of 2008, 2007, and 2006.
Patterson-UTI: Cheap for a reason
Again, I understand that not everyone thinks free cash flow is important. But for those who argue it isn't, I'd proffer the following: If Patterson was really generating as much cash profit as it claimed to be "earning" -- year after year after year -- do you think it would have $400 million in net debt on its balance sheet? Seems to me, a deficiency in cash production is one key reason Patterson is so deeply in hock -- and a key reason the stock looks as "cheap" as it does today.
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